Magazine

Behind The EU Backlash

July 10, 2005

By Laura D'Andrea Tyson The recent votes against the European Union Constitution by the citizens of France and the Netherlands were a stunning rebuke to globalization. Above all else, fears about global trade's economic downside mobilized those on both the right and left in Europe to hand a resounding defeat to their leaders. Similar fears are fueling the growing protectionist sentiment among U.S. voters, reflected in congressional threats to reject the Central American-Dominican Republic Free Trade Agreement and to slap huge tariffs on Chinese imports. Such fears of globalization by millions of citizens throughout the advanced western economies are usually dismissed and sometimes even derided by most economists and business leaders. But even proponents of globalization -- myself among them -- must admit there will be winners and losers in the process. And we should champion policies that increase the ranks of the former while alleviating the pain suffered by the latter.

Many EU voters may not understand economic theory, but their intuitive fears of potential job and wage losses caused by globalization rest on a sound analytical foundation. According to Richard B. Freeman, a labor economist at Harvard University, the global labor force has more than doubled over the past 15 years as a result of the entrance of China, India, and the former Soviet Union into the global system of production and trade. These new workers brought little physical capital with them, so their arrival cut the global capital-to-labor ratio to about half what it had been. That's bad news because this ratio is the primary determinant of worker productivity and pay. And Freeman estimates that despite the huge savings of China and other emerging nations, it will take at least three decades to restore the capital-labor ratio to previous levels.

HAVING TWICE AS MANY WORKERS and nearly the same amount of capital places great pressure on labor markets throughout the world. Many low-skilled workers in both emerging-market economies such as Brazil and developed market economies such as the U.S. and France are discovering that they cannot compete with Chinese or Indian counterparts who are equally productive yet willing to work for dramatically lower wages. In theory, skilled workers in western economies should benefit from globalization if the terms of trade shift in favor of skill-intensive products they produce, such as advanced machinery and high-value-added services, and against labor-intensive products they consume, such as apparel. But as China and India rapidly upgrade their workforces through education, even many college grads in Europe and the U.S. will find themselves competing with foreign workers who command much lower pay.

The doubling of the global labor force means average real wages are likely to grow more slowly in advanced industrial countries and that many workers, even those with considerable skills and education, will face painful job dislocation and stagnant or falling real wages. A new book by Clyde Prestowitz, Three Billion New Capitalists: The Great Shift of Wealth and Power to the East, describes these risks in compelling detail.

But the future may not turn out to be as difficult for workers as Freeman and Prestowitz predict, says Martin Wolf in Why Globalization Works. First, most jobs in developed economies are in services, and most services can still only be consumed and produced locally. McKinsey Global Institute estimates that only about 11% of the 1.46 billion service jobs worldwide could be performed in foreign locations anytime soon. Second, capital -- defined as not just physical capital but also social capital, such as laws and culture, and human capital, such as education, language skills, and experience -- is not nearly as mobile across borders as is commonly thought. That means workers in advanced countries may continue to enjoy productivity and wage advantages. Finally, there are still few truly multinational companies, and they continue to locate more than 75% of their production, employment, and capital spending in their home countries.

How should policymakers respond to the risks posed by globalization? In a recent speech to the European Parliament, British Prime Minister Tony Blair called for a new social model that redirects the EU budget from huge agricultural subsidies that benefit the few to investments in knowledge and skills, research, aid to small business, and labor-market policies that benefit the many. That would help create jobs of the future. Without an activist agenda such as Blair's, fear could trigger a protectionist backlash that would undermine global growth -- leaving the world's workers even worse off.

Laura D'Andrea Tyson is dean of London Business School (ltyson@london.edu)